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Chapter 2

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David Gray

Chapter 2- Thinking like an Economist Adam Smith - The ‘father’ of modern microeconomics - Greatest contribution was seeing how markets function - The ‘invisible hand’ notion - All economic agents are motivated by greed rather than generosity…. – Consumers want the lowest possible price – Producers want the highest possible price – So how could the economic system work at all? – Due to the forces of competition, everyone’s greed is channeled by the ‘invisible hand’ such that it serves the common good. • My greed is offset by your greed. Scientific method - Economics is supposed to be a social SCIENCE - Social in that it deals with human behaviour - Science in that there should be some method involved • Draw up a conjecture that aims to explain some economic phenomenon • Attempt to find evidence to PROVE it! –In the context of law, this means building a case • In economics, it often means gathering relevant data and carrying out EMPIRICAL validation • All in all, you must leave yourself open to being proven wrong in order to be scientific –That is called REFUTABILITY Example of scientific economic research – Proposition: increases in the minimum wage lead to decreases in employment, all other factors held constant • Warning: keep your mind open. It may or may not be true, so let’s be Dispassionate and appeal to the evidence • One possible technique: Collect monthly data on the number of teenagers employed in each province over a long interval • Observe what happens when one province, like Ont., raises its minimum wage, while the other provinces hold theirs fixed • Carry out a before/after analysis: look for a greater drop in teenage employment in Ont. than in the other provinces. If so, there is evidence that the minimum wage ‘kills jobs’ Example of unscientific ‘research’ – Proposition: increases in the minimum wage lead to decreases in employment, all other factors held constant • Warning: keep your mind closed. It is obviously true or false, so let’s be passionate and not waste time by appealing to the evidence. Instead, rely on ideology and superstition • From the right: firms have to fire workers if the wage increases (otherwise they will go out of business) • From the left: firms have to hire workers if the wage increases (because workers are spending more, and hence firms are selling more) Another example of unscientific ‘research’ – Proposition: The business entities acquired by Bain Capital are ‘exporting’ jobs to countries with ‘cheap labour’ in order to pad profits and undermine living standards of America’s middle class • Warning: keep your mind closed. It is obviously true, so let’s be passionate and not waste time by appealing to the evidence • rely on anecdotes – here’s is ONE example Assumptions and models Both of these groups have a MODEL in their minds about how the labour market functions – To be useful at all, the models have to omit a lot of detail, and thus they are generalised - Any economic model good or bad, is based on unproven ASSUMPTIONS, from which subsequent logical deductions are made - They are designed to SIMPLIFY the model so that conjectures can be made - Assumptions are usually unrealistic The PPF The Production possibilities frontier (PPF) is our first economic model. – also called A TRANSFORMATION CURVE. Assume that the economy produces two goods, "guns and butter". – A metaphor for social spendin
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